Solar Companies Face Headwinds

Solar companies in America and Europe have been facing sunstroke of late, due to numerous factors. Competition from heavily subsidized panel makers in China, coupled with a global mountain of inventory, has sent solar panel prices tumbling by 70% in the past 24 months. Let's take a Foolish look at what this means for solar energy companies.

Some bad newsThree solar panel makers in the U.S. have filed for bankruptcy protection. California-based Solyndra, which had received more than $500 million in federal loan guarantees, is the latest. Earlier in August, Spectrawatt, an Intel spinoff, and Massachusetts-based Evergreen Solar filed for bankruptcy protection, citing too much competition from Chinese panel makers.

Solyndra and Evergreen Solar had, in fact, invented unique technologies that allowed them to make solar panels using less polysilicon, which is the main ingredient of any photovoltaic cell. But polysilicon prices have fallen like a rock, making Solyndra and Evergreen's manufacturing processes less cost effective.

China heats things upChinese competitors are fast outpacing U.S. and European companies in the solar energy race, thanks to cheap credit being offered by Chinese banks and government support in the form of free land. These incentives add to the economies of scale and price competitiveness of these companies.

One key difference between subsidies in the U.S. and China is the way they are given out. In China, subsidies are offered to manufacturers. While in the U.S., buyers of renewable energy are subsidized for their purchase (irrespective of who the producer is). Thus, the Chinese get an extra edge here.

Inventory and input costsAt present, the solar energy market is bogged down because of subsidy cuts in Europe and a buildup of inventories, caused by overproduction from Chinese players. Unfortunately, according to analysts, this extra stockpile is likely to stay until 2013.

When supply exceeds demand, market prices are bound to go down. This phenomenon works in favor of low-cost Chinese producers and kills off those that produce at higher costs.

Polysilicon, the stuff inside solar cells that makes electricity out of the sun's light, forms a higher percentage of costs for Chinese firms such as JinkoSolar (NYS: JKS) , Trina Solar (NYS: TSL) , and Yingli Green Energy (NYS: YGE) . So falling prices have increased their competitiveness as they mostly buy this essential material at spot prices.

The numbersSolar companies have seen a general trend of declining margins and rising costs, with a few exceptions.

For instance, Suntech Power Holdings (NYS: STP) has seen its second-quarter revenue expand from $25.1 million to $30 million. But despite this, its net losses widened to $259.5 million from $174.9 million in the year-ago quarter due to inventory writedowns and other one-time charges related to cancelation of a wafer supply agreement with MEMC (NYS: WFR) .

Trina Solar's second-quarter revenues rose from $371 million to $560 million, but soaring costs and operating expenses ate up everything, leading to a big drop in net income from $38 million to just $11.8 million this quarter.

First Solar's second-quarter revenues declined slightly to $532 million from $588 million in the year-ago quarter. Rising costs and expenses did not spare this company, either. Second-quarter net income dropped from $159 million to just $61 million in the quarter.

On the sunnier side of things, Chinese manufacturer Yingli's second-quarter revenues climbed from $2.7 billion to $4.3 billion. However, the company's gross profits remained relatively flat due to a sharp rise in cost of goods sold, from $1.7 billion to $3.4 billion. Despite this, Yingli managed to post an impressive increase in second-quarter net income, from $217 million to $375 million.

JinkoSolar has seen its second-quarter revenues swell from $900 million to $2.2 billion. Its net income for the quarter has also risen, from $180 million to $235 million.

The sun will riseDemand for renewable sources of energy such as solar energy is expected to go up, primarily on the back of future increases in oil prices and due to waning global support for nuclear power. For now, consolidation in this sector will probably kill many companies that don't keep costs at rock bottom. The future is bright for the sector as a whole, but panel producers would love to find ways of protecting their bottom lines from the scorching competition.